To improve credit scores, pay down credit cards first

Jun. 25, 2009 - 11:35AM
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Last Updated: Jun. 25, 2009 - 11:35AM |

A 22-year-old Marine deployed to Afghanistan wants to get his credit score in shape.

The Marine, who did not sign his e-mail, said he has made some bad decisions, including buying a tractor he couldn't afford and taking out a truck loan and a car loan. He hasn't checked his credit score in a while but suspects it's low. To raise it, he asks whether it's better to pay off a car loan or a credit card first.

Paying down installment loans, like car loans, will help your credit score — but not as much as paying down credit cards, said John Gannon, president of FINRA Investor Education Foundation.

"If you have high outstanding balances on credit cards, it will affect your credit score negatively," Gannon said.

A credit score is a number from 300 to 850 that summarizes your credit risk based on your credit report. Most lenders consider scores above 700 to be good, and above 650 is fair, according to http://www.myFICO.com">www.myFICO.com and the Consumer Federation of America.

Lenders use those scores to determine whether to loan you money and how much interest to charge, so a good credit score can mean lower monthly payments. Go to http://www.myFICO.com">www.myFICO.com for a good calculator showing the effect of various credit scores on interest rates for mortgages and car loans.

A good credit score can save you money in other ways. Insurance companies often use credit scores to determine how much you'll pay for car insurance, for example.

The most important component is your payment history, Gannon said, so it's important to make at least the minimum payments on those loans and credit cards.

One issue beyond your control is your credit history. A 22-year-old will not have the history of a 55-year-old simply because he hasn't lived long enough to build it.

Don't max out the credit cards and credit lines available to you. A good rule of thumb, Gannon said, is not to exceed 30 percent of the available credit on your cards. So if your limit is $1,000, try to keep the balance below $300. (Better yet, don't carry a balance.)

If you have three credit cards, is it better to pay down the cards so that the debt on each is less than 30 percent of available credit or to pay off one card at a time?

That depends on your goal, Gannon said. If you're trying to improve your credit score, the best thing to do is get all three under the 30 percent threshold. But for money management reasons, you might want to pay off one card at a time. Some people pay off the card with the highest interest rate first. Others pay off the card with the lowest balance first; having one fewer debt can give you a psychological boost.

It's better not to close accounts once you've paid them off — that can lower your credit score, Gannon said.

FINRA and http://www.brightscore.com">Brightscore.com provide free credit scores to active-duty members and their spouses who are having trouble with their finances. Credit scores also are available to activated National Guard and reserve members.

Deployed troops get fee break

USAA says it will reimburse service members deployed overseas for the foreign transaction fees charged on MasterCard and Visa credit or debit card purchases made overseas.

Those fees, assessed by MasterCard and Visa, are about 1 percent of the purchase price, USAA spokesman Michael Kelly said.

MasterCard and Visa will continue to charge USAA these fees, but the company will not pass the cost on to its deployed members. The benefit applies to USAA members for up to 12 months from the time they notify USAA in advance of an overseas deployment. The benefit applies from the time you notify USAA, so it's best to notify the organization a few days before deploying, Kelly said.

It's not retroactive. So if you're deployed now, notify USAA as soon as possible.